An extremist, not a fanatic

January 22, 2014

Who needs productivity?

"Productivity isn't everything, but in the long run it is almost everything." If Paul Krugman's famous saying is right, the UK economy is in trouble because today's figures show that total hours worked rose by 1.1% in the last three months, which implies that output per hour is falling, and is well below its pre-recession peak. And Duncan thinks Krugman is right:

Unless we see a pick-up in productivity growth soon then the UK risks much slower growth, and lower living standards, in the future.

But could it be that they are both wrong, and that stagnant productivity and decent output growth are compatible for at least a few more years?

To see my point, consider the standard story about why productivity matters. This says that if there's no productivity growth, output growth requires more employment and this higher demand for labour will raise wage growth. This will lead either to higher price inflation and hence higher interest rates or to a profit squeeze. Either higher rates or a profit squeeze would reduce firms' motives to expand and so kill off growth. Sustainable output growth thus requires productivity growth.

But there's something wrong with this story. As Jon Philpott points out, wage inflation has so far not risen at all in response to falling unemployment. There are several reasons why this might be, which might continue to hold down wages:

- Unemployment is higher than the jobless count suggests, implying that there's much more pent-up supply of labour. If we add to the unemployment count the inactive wanting work and part-timers wanting full-time work, there are still over six million people unemployed or under-employed. And even if employment grows by 2% a year for the next five years, there'd still be three million jobless on this measure.

- Memories of the great recession will have a scarring effect, by making workers scared to push for higher wages.

- The mass supply of labour from the far east will continue to hold wages down (pdf).

- Pay restraint and job losses in the public sector - the OBR foresees general government employment falling by over 500,000 in the next four years - will hold down private sector wage growth.

If these factors continue, we could see more of what we've had recently - GDP growth plus jobs growth without much inflation and hence no need for higher interest rates.

This need not imply a squeeze on profits. Wage growth of one per cent and zero productivity growth implies unit wage costs of one per cent. Barring adverse commodity price shocks, this is consistent with stable profit margins at low inflation. And with output growth raising the output-capital ratio, this gives room for profit rates to grow, thus maintaining or even increasing firms's motives to invest.

Granted, this story implies a fall in real wages for those in work. But this is offset by rising incomes as other move into work. In the year to Q3, real disposable incomes rose despite falling real wages, in part because of rising employment.

There is, of course, a lot that could go wrong with this scenario, and I'm not sure I believe it myself - though you shouldn't give a damn what I believe.But there's one thing that lends it a little credence.It's that some research has found that the link between output growth and productivity growth even over longish periods isn't as strong as you might think.

So, perhaps we should consider the possibility that we'll see continued stagnant productivity and output growth for a few more years. This would imply that the wage squeeze will continue even as unemployment falls.

Comments

Or could it be that the productivity figures are misleading - because business hasn't responded to the recession in the way marginalists believe.

Unemployment didn't go up by very much, and productivity went down. So there was an amount of labour hoarding going on - essentially the private sector was paying 'unemployment benefit' and automatically stabilising their demand at a subdued level, but enough to justify the decision to retain staff.

That should start to reverse as demand picks up again from the additional wages.

Krugman is talking about productivity as in the production possibility frontier (productive potential), all these data on UK productivity reflect capacity utilisation (and productive potential). These distinctions are basic but get lost too often.

Neil Wilson what makes you think labor hoarding is a foreign idea to marginalists? I imagine all you need is a model with job-specific human capital , costs of hiring, training etc. and it will predict profit maximizing firms will hoard labour in a recession.

The word productivity smacks of widget factories and clipboards and obvious improvement measures. But what is productive work? For example, does turning down planning applications count, or giving obfuscative legal advice to lardy lords, does delaying airport runway planning until after an election count and does the current NoW trial count as productive work?

Now all these activities result in some money being shuffled around and I can see how a humble burger-flipper adds to the common weal but I cannot help feeling that a lot of 'jobs' are concerned with pushing the world forwards and backwards with little net effect. Is there a measure for this phenomenon - for 'productive' does not seem quite the right word.

@ Neil, Pablo - A few months ago, I was sympathetic to the labour hoarding idea. However, the fact that productivity growth hasn't picked up, despite a strong recovery in output since the spring, is inconsistent with it. This just deepens the puzzle of why productivity's stagnated.

I am more aware of firms keeping people on, especially in manufacturing, but on reduced hours. So they wrk 4 days out of 5 for example.

rogerh - the more the burger flipper is productive the more pressure there is on the doctor to be productive, in treating heart disease, among others. The less productive the environmental health inspector the more productive the anti disease people have to be. Your view of 'productive' smacks of nursery school reasoning to me.

@Chris, the weak productivity growth could reflect the degree to which the effects of labour-hoarding in 20090/10 have become the norm since (i.e. a form of hysteresis). This would be consistent with the low levels of capital investment over the period.

If business investment picks up over the next 12 months, we could see productivity begin to grow faster again, however this might also result in employment growth slowing down.

"So there was an amount of labour hoarding going on - essentially the private sector was paying 'unemployment benefit' and automatically stabilising their demand at a subdued level, but enough to justify the decision to retain staff."

What are the mechanics of this? Firms pay people while they produce nothing - cash flow, profit implications? Or firms produce something and build up stocks of unsold goods? In which case, it is surely wrong to call this paying 'unemployment benefit'. Also, getting rid of skilled workers in a short term downturn can be very costly in the long term.

The less people work, the more they resort to crime as a way of deriving income from the criminal industrial complex. This creates demand for more police and guards guarding the incarceration factories. So eventually, everyone is either incarcerated or working in the criminal justice system and at the point we have equilibrium.

The term productivity belongs to the age of mass semi-automated manufacturing.
It does not apply directly to service industries nor to mass manufacturing done by robots. It does not apply to zero hours contract employment in the same way as full-time employment. The zero hours worker works only when work is 100% available - the full time worker may only work productively for 2 hours a day.
If construction imports pre-fabricated buildings and assembles them on site then "productivity" soars but no one is working any harder.
If Google doubled its tiny staff then "productivity" would halve but profits hardly change at all or possibly rise.

Value added employment is the better way to think of things. Can the employer reliably and sustainably charge his customer or client more than cost?

Productivity isn't really a measure of people working harder but is more a measure of technological development, i.e. pre fabricated buildings represent an increase in productivity over previous methods of constructing buildings.

Incidentally, the more productivity increases the more can resources be applied to areas such as Planning development officers, legal advisors etc etc

"Can the employer reliably and sustainably charge his customer or client more than cost?"

The answer is no, Mercantilism, as this is called, leads to the ruin of the producer. You can make money from cheating in some circumstances, private companies often make money this way via government contracts (fleecing the public purse), but a sustained level of cheating the customer/client will not lead to growth and is not what marks out capitalism.

I thought "mercantilism" referred not to the policy of any individual business, but to a national policy of hoarding gold (or in more recent times, exporting unemployment) by running a foreign trade surplus.